Professional Documents
Culture Documents
Information Exchange
By
Dr Rainer Nitsche
Nils von Hinten-Reed
June 2004
Contents
1
2
3
Tables
Table 1: Effect on consumer welfare in standard static oligopoly models ..............................16
Table 2: Information exchange that may facilitate coordination .............................................25
Table 3: Information exchange that may help detect cheating ................................................27
Table 4: Information exchange that may improve the ability or reduce the cost of punishment
..........................................................................................................................................28
Figures
Figure 1: Consumer surplus effect of improved information about demand...........................13
1 Executive summary
The European Liner Affairs Association (ELAA) has asked CRA to look at the economic
implications of information exchange. In the context of DG Competitions review of
Regulation 4056/86, we understand that the ELAA wishes to propose an information
exchange system as a potential alternative to the current liner conferences. In this paper we
review the economic literature on information exchange and investigate the likely
competitive effects of information exchange.
In the past competition policy conclusions based on the economic literature rested mainly on
a comparison of the effects of information exchange in static models of oligopoly and
dynamic models of collusion. This work has found that the effects of information exchange in
static models depend on the nature of competition. Under quantity competition, for example,
information exchange improves consumer surplus and welfare but under price competition it
may not. The main driver of this result is the output adjustment effect. When firms set
quantities and there is uncertainty about demand for this output, information exchange about
future demand improves each firms estimates of future demand. Thus, firms produce more
(relative to the situation without information exchange) when they exchange information
about future demand and future demand is high and they produce less if future demand is
low. The first effect (more quantity if demand is high) is beneficial for consumers and
outweighs the second effect (less quantity if demand is low), which is negative for
consumers. When firms set prices the output adjustment effect is different (more quantity if
demand is low and vice versa) and the negative effect outweighs the positive effect.
It has further been argued that under quantity competition firms may not have an incentive to
exchange information in static models.
The economic literature on dynamic models of collusion highlighted that information
exchange can improve the ability to collude.
Based on these findings it has been suggested by some economists that competition
authorities should (see Khn and Vives 1995):
Generally not allow the exchange of individual price and quantity data;
Allow the exchange of aggregate data through trade associations (unless there is
evidence of collusion);
Not allow information exchange about intended future pricing unless it goes along
with a commitment to maximal prices for consumers.
In this paper we take into account more recent research and a broader set of effects. Our
analysis has shown that the recommendations above should not be applied across the board.
In particular, we find, first, that quantity-setting firms are much more likely to have a pro-
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Executive summary
competitive incentive to share information than believed in the past1 and, second, we identify
a number of further benefits of information exchange.
Economic literature dating back centuries identifies the generation of information as key to
generating competitive outcomes. Price signals lie at the heart of the market economy.
Independent actors strive to maximise their profits to the benefit of the entire society. This
idea is at the heart of the famous invisible hand of Adam Smith (1776). Friedrich von Hayek
(1945 and 1968) describes competition as a discovery mechanism that is required to generate
the information necessary for economic progress. Since then economic research has identified
a large number of beneficial effects of information exchange.
Thus, the generation and use of information is traditionally seen as important for consumer
welfare. In fact the ability to generate and disseminate information is seen as an important
aspect for explaining the existence of the variety of institutional arrangements between
market transactions and transactions within organisations. This suggests the intuition that
more information exchange is good for consumers. We discuss the following effects:
Information exchange leads to better outcomes on which firm produces how much. As
a result information exchange may facilitate entry and exit in an industry, an aspect of
dynamic competition widely ignored in the earlier literature on information exchange.
Information exchange can lower search costs and thereby lower costs for customers.
By the same reasoning information exchange about common input variables can lower
the input costs across all firms, leading to lower prices that benefit consumers.
More realistic modelling of information types has shown that in the standard quantity-setting model, first,
firms do have an incentive to exchange information and, second, that this information exchange is valuable
for consumers and welfare. This questions some of the previous policy conclusions that rest on the
argument that when information exchange is beneficial for consumers, firms may have no incentive to
exchange the information.
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Executive summary
Information exchange about common value parameters can substitute the beneficial
effects of forward markets (which will not always emerge as a market outcome) and
improve the market outcome by mitigating the winners curse, and increasing
economic efficiency.
The very coordination that may follow the exchange of information may have
beneficial effects for consumers and welfare. If completely uncoordinated competition
leads to market failure, then some coordination may be desirable.
However, it is well known that information can also be used to eliminate competition and
information exchange can therefore harm consumers. For example, producers can use the
exchange of information to coordinate their behaviour in the market in order to keep prices
above the competitive level, limit production or the amount of new capacity, or share the
market. The new EC Merger Guidelines provide a good summary of the environment where
coordination may occur:
Coordination is more likely to emerge in markets where it is relatively simple to reach a
common understanding on the terms of coordination. In addition, three conditions are
necessary for coordination to be sustainable. First, the coordinating firms must be able to
monitor to a sufficient degree whether the terms of coordination are being adhered to. Second,
discipline requires that there is some form of credible deterrent mechanism that can be
activated if deviation is detected. Third, the reactions of outsiders, such as current and future
competitors not participating in the coordination, as well as customers, should not be able to
jeopardise the results expected from the coordination. (EC Merger Guidelines, Para 41)
Information exchange may facilitate the agreement, the monitoring and the punishment and
may therefore lead to or stabilise collusion. This suggests the intuition more information
exchange is bad for consumers.
It follows that communication and information revelation can have pro-consumer and anticompetitive impacts depending on whether collusion is likely to be a problem or not and
depending on the type and characteristics of the information that is exchanged. Since there is
no general intuition with regard to the effect of information exchange, it is necessary to study
the specific context for each industry.
The extensive economic literature on collusion has generated some useful conclusions on the
types of information that may facilitate anti-competitive effects. Combined with the results
from the static models this has lead to an assessment of different information types,
concluding that, in particular, the exchange of individualised pricing and quantity data is
likely to be only motivated by the intent to collude. This has lead to a critical attitude towards
this kind of information exchange. More recent research has shed further light on the issue
and leads to a more differentiated view on information exchange about price and quantity
data. The following findings are relevant:
Detailed case studies of collusive arrangements have shown that effective collusion
requires agreement and monitoring of much more than just the price or the
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Executive summary
Most existing economic models are weak in explaining how a different equilibrium is
achieved. If firms respond to rivals actions by imitating their behaviour, information
exchange may lead to competitive outcomes. Experimental evidence provides some
confirmation for these results.
The requirements for collusion are cumulative as in addition to further requirements, like
barriers to entry, all the following elements need to be fulfilled: agreement, monitoring and
the ability to punish. Information about past prices, sales, cost and demand facilitates the
detection of cheating which is important for the stability of collusive arrangements.
Information about future prices, sales, capacities, cost, and demand is more important for
reaching an agreement than for monitoring purposes. More detailed case study research
shows that effective collusion requires a significant range of information. Thus, showing that
collusion is impossible due to a lack of information about crucial details or as a result of other
aspects of market structure is sufficient for changing the results significantly: information
exchange will then have a positive effect on consumer welfare, with the possible exception of
price competition.
What can be concluded about the competitive impact of exchanging different types of
information? From the point of view of collusion, ignoring the beneficial effects of
information exchange, we obtain the standard results that lead to the following conjectures:
Exchange of aggregate data on any of the above: small negative effect (if any)
Given that on the one hand information exchange about individualised price and cost data
raises more competition concerns than aggregated or anonymous information, and on the
other hand the beneficial efficiency effects of information exchange depend on knowledge
about future demand and cost, it is a relevant question how information can be aggregated
and/or anonymised in a way so that the competition concerns are addressed but the benefits
are retained. Here the result that disaggregated and individualised information about demand
can have a significant beneficial effect on consumers is relevant and suggests a trade off. The
net-effect of information exchange will depend on the circumstances in each industry.
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Executive summary
Market participants can learn from each other and firms have different knowledge
about different parts of the market.
The information is important for decisions which have a significant welfare effect.
The aim of this paper is to shed some light on the different types and characteristics of
information that matter for the assessment of information exchange, to understand the criteria
for evaluating the settings in which information exchange may have a negative effect, and to
highlight when institutions or practices that improve information exchange have a beneficial
effect on consumer welfare.
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Information exchange
2 Information exchange
Advances in economic theory have enabled economists to make competitive distinctions
between different types of information exchanged between firms. Broadly, both the expected
beneficial effect on consumers and the potential harmful effects for competition depend on
the type and characteristics of the information that is exchanged and the nature of competition
in the market. The following factors influence the results:
1. What is the information exchange about: firms own prices, sales, capacities, cost,
demand or other parameters? Competition authorities are usually more suspicious
when information is exchanged about prices and quantities because this information is
often essential for monitoring deviations from a collusive arrangement and hence
enforcing collusion. Exchange of information on cost and demand is usually looked at
more favourably. However, in practice information about prices and quantities is often
used to convey information about cost or demand. For example, sharing information
about past or current prices and quantities informs other players about demand and
allows inferences to be made about the costs of rival firms during the relevant period.
This demand and cost information is useful as current or recent demand (cost) is a
central element for predicting future demand (cost).
2. Specificity: firm specific (private value) or industry specific (common value)?
Does private information that can be shared pertain to common values or private
values? Common values relate to information from which others could learn about
their own estimates of, for instance, industry demand or common input parameters.
Private values relate to information that does not convey common value information.
Examples include firm-specific production costs and demand shocks.
3. Time period: past, present, future? Effective collusion requires coordination (which
can be supported by exchanging information about future plans) and monitoring
(which requires information about actual behaviour).
4. Aggregation and individualisation: aggregated (anonymous) information or
disaggregated (individualised or anonymous) information? The level of anonymity
and aggregation of the information that is exchanged (completely aggregated,
aggregated by market/product category, disaggregated and anonymous, disaggregated
and individualised) and the asymmetry of the value of the information to firms (e.g.
whether it is valuable to know who or where a certain estimate has been made or
whether it is sufficient to know the average of the private signals in the entire
industry) influence the effect of information exchange:
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Information exchange
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leads to an efficient allocation of goods (to those that value them most);
The famous invisible hand of Adam Smith (1776) relies on the exchange of
information. Independent actors can plan and conduct their economic activity to the
benefit of the whole society by relying on price signals.
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In a world without information about demand and rivals activities, firms would have to
permanently adapt to changing circumstances by a trial and error process. As a Commissioner
of the US Federal Trade Commission put it with regard to pricing:
Information about prices helps businesses make informed decisions about the prices at which
they will offer their products and services, eliminating the need for a more costly trial and
error process. Price information is useful to both consumers and businesses to inform buying
decisions (Azcuenaga 1994, p. 4).
While a trial and error approach may be of little cost in some industries, it clearly becomes
more costly when development times and investments are required for each trial.
Standardising services in order to allow meaningful price comparisons may intensify
competition. Knowledge about high prices is a precondition to encouraging entry.
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A number of the effects below have been shown under the assumption of constant marginal cost and linear
demand.
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P
aH
a*
Positive externalities
for consumers in
high demand states
aL
Negative externalities
for consumers in low
demand states
QL
Q* QH
Note that the monopolist always benefits from information exchange. Indeed, the greater the
uncertainty, the greater the gain from information exchange for the monopolist. Consumer
surplus and welfare are higher if prices are fixed and output is variable across different states
of demand.
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there is more output adjustment in response to the shared information, which is good for
consumers.
Note, however, that this also implies that, from the point of view of a representative firm,
information sharing leads to less variable residual demand, i.e. residual demand is less
different from the original estimate, compared to a situation when the representative firm
learns about the true state of demand but rivals do not. This has two effects:
With lower variability of demand the value of the individual firms own information
is decreased.
Moreover, the more variability of demand is reduced, the less valuable becomes the
representative firms improvement of decision making.
If products are close substitutes, the variability of the demand from the representative firms
point of view is almost zero and the loss caused by the reduced variation in demand (due to
information exchange) outweighs the gains from the improved precision of the information
about demand that results from the information exchange.
This may result in firms not wanting to exchange information in monopolistic quantity
competition with common demand uncertainty (provided that goods are close enough
substitutes). While the first effect remains, a firm benefits from the improvement of
information, the fact that the rivals obtain information creates a negative externality on the
representative firm.
Suppose firms set quantities and information is firm specific. Now sharing information
increases the variability of demand from the point of view of the individual firm as before
information exchange the firms own information (or signal) is taken as an indication of the
information that the rivals received. Therefore, high own values would lead to assuming high
values for the others. Thus, average output varies positively with the nature of the shock.
After information sharing the average output varies less systematically with regard to the
information received by the representative firm. This makes demand more variable from this
firms point of view, which leads to a positive external effect of information exchange.
More generally, the result that firms may not want to share information is crucially dependent
on the fact that the uncertainty is perfectly correlated. Consider for example a multi-market
setting in which each firm has superior information in a few markets, then the loss for a firm
is giving up its information advantage in the markets about which it is well informed and the
gain is the good information in the many other markets where others have superior
information. In this setting one can find both an incentive to share information and
improvements in consumer surplus and welfare (see Novshek and Thoman 1998). This
finding has important implications for policy recommendations that suggest that aggregating
data is competitively benign. We will return to it below.
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setting. The following table summarises the effects on consumer welfare in standard static
oligopoly models.3
Price competition
Quantity competition
+
+
+
+
These models do not capture collusion. We investigate potential effects of information exchange on the
likelihood of collusion in Section 4.
A standard example is the competitive positioning of sellers of ice-cream on a beach. Consumers and sellers
would prefer if the sellers locations are dispersed. This is not necessarily the market outcome. Consider, for
example, the case of two sellers. Each seller has an incentive to position itself in the center of the beach if
the rival positioned itself in the center. Without coordination both players may therefore locate in the center,
which is detrimental for consumers. This reasoning can also be used for the positioning of differentiated
products.
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Unfortunately, there is little quantifiable evidence on the benefits that stem from lowering the
search costs of firms and consumers.
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If bidders can learn from the information of other bidders (there is a common value5),
information exchange can improve the estimate of the value of the good that is to be
auctioned. In most bidding situations, each bidder has some uncertainty about the true value
of the items being auctioned. Bidders do not want to win by bidding too high or above
market levels. They anticipate that if their valuation turns out to be higher than that of all
other bidders (that have some knowledge about the true value of the good) they are likely to
have overestimated the value. Anticipating the winners curse leads to bids below the
valuation. The more uncertainty there is the bigger the negative effect. This is known as the
winners curse effect. This leads to suboptimal auction outcomes.
Auction design therefore makes use of iterative or round-by-round bidding. This provides
pricing information to bidders so they can use to bid more aggressively and closer to their
true valuations without risk of over-bidding.
Evans and Mellsop (2003) investigated the beneficial effect of information exchange in such
a context. They investigate information exchange among meatpacking companies in New
Zealand. In meatpacking firms face considerable uncertainty about the weekly supply of
livestock and about market prices for the processed product. They show that information
exchange mitigates the winners curse problem and thereby leads to efficiency gains. They
also investigate why no forward market emerged, which could have resolved the information
problem without recourse to information exchange. They argue that ...the transaction costs
in forming such a market given the informational and locational characteristics particularly
the scattered nature of one side of the market, the need to verify quality and the costs of
goods exchanged may have outweighed the gains from trade that it would imply (Evans
and Mellsop 2003, p. 26). Thus information exchange is the best solution to resolve the
winners curse problem.
3.8 Efficient allocation of goods (to those that value them most)
One further implication of the uncertainty about the value of goods is that the goods will not
necessarily be allocated to those that value it most. Given the uncertainty about the valuation
of the good and the valuation of the competing bidders, bids will be shaded so much and to
such varying degrees that there is no guarantee that the bidder with the highest valuation
wins. This is inefficient for society.
Loosely speaking, an item with a strong private value component is one in which one bidders valuation of
the item is not correlated with or dependent very much on the valuations other bidders have for the item. In
contrast, an item with a strong common value component is one in which one bidders valuation of the item
is strongly correlated with or dependent on the valuations other bidders have.
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It is noteworthy that academic research has advanced quite significantly with regard to the
thinking on the private benefits of information exchange, generally with a more positive view
(see Novshek and Thoman 1998; Christensen and Caves 1997, Matutes 2001, Doyle and
Snyder 1999).
As we explain in Section 4 information about price and quantity data will be of greater
concern to competition authorities than the exchange of aggregated information. Moreover,
while the research we reported above has shown that in many theoretical instances
information exchange leads to welfare improvements, this research also showed that in many
of these situations it would be sufficient to exchange aggregated information and firms
themselves would only wish to exchange disaggregated and individualised information in
order to increase market power (ease collusion).
An influential study prepared for the European Commission argued:
Indeed, it is hard to find plausible business reasons, other than collusion, that might justify
the exchange of individual price and output data (Khn and Vives 1995, p. 115)
This conclusion has now been found to be correct only in a very special case: it will hold if
and only if the object of the uncertainty (i.e. demand shocks) are perfectly correlated, so that
knowing about average demand one also knows about all the relevant private information.
However, in most industries different firms will know better about different aspects of the
market. By aggregating information important content is lost. As a result firms have a noncollusive incentive to share information.
This result is based on Novshek and Thoman (1998), who analyse a model in which firms sell
the same product in a number of independent regions and do not coordinate. As is to be
expected, they find that disaggregation of information into regions is desirable. But even
within a region when the precision of information varies across firms, the average does not
provide sufficient information and the information (or signals) need to be weighted
according to their precision:
This means that if information is shared as a list of the members signals, then an
anonymous list is inferior to a non-anonymous list, since firms do not know the weight to
attach to a signal without knowing who received the signal [] Any other information
exchange mechanism (no sharing, or anonymous disaggregated sharing, or aggregated
sharing, either as an overall average or as market-by-market averages) provides less precise
information to firms and is inferior in consumers and total surplus (Novshek and Thoman,
1998, p. 332).
Information exchange not only allows actors to take meaningful unilateral decisions as
explained above. It also allows producers to resolve coordination problems that would
otherwise lead to under-investment or other forms of market failure (see Section 3.2 and 3.4).
Trade associations are created to help information exchange. They gather and disseminate
information on prices, quantities, investment and closure decisions (capacity), employment
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figures, wages, and product standards. This is to facilitate information exchange between
firms in the respective industry and to improve communication with regulators, government
and customers.
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See Genesove and Mullin (2001) for a detailed description for how communication may help coordinating
and resolving the monitoring problem.
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Thus, it seems that, quite generally, information exchange that concerns future plans
regarding prices, sales, and capacities tends to facilitate coordination. Information about
future demand or cost seems to be of less importance unless it is combined with information
about prices, sales and capacities or allows others to infer that information.
However, information on the present or the recent past may also help coordination. If for
example a market leader regularly publishes prices, this may serve as the focal point for the
colluding firms to follow.
One way to address concerns about the improved ability to coordinate is to aggregate
(anonymise) the data. If this method is effective (i.e. individual operators cannot be inferred),
the ability to reach an agreement will usually be significantly impaired. For example it will
be much less clear how a fair division of profits can be agreed if it is not known what the cost
and demand situation in different localised markets are.8
The assessment of whether private or public information exchange facilitates coordination
more depends on the intent of the inquiry. There are two opposing effects: on the one hand
the publication of prices and sales data can simplify the information transmission process. On
the other hand, if a private information exchange network is not too costly, it has the
advantage that it will be much more difficult for other market participants or competition
authorities to detect and prove the collusive behaviour. Thus, while from an ex post point of
view the finding of a private information network may be a strong indication of collusive
behaviour, it does not follow that competition authorities should therefore ex ante be more
open to public information. The key point to investigate is whether public information would
facilitate the information transmission, which would otherwise be prohibitively costly. If not,
public information should be preferred from the point of view of competition authorities.
A famous example for the collusion facilitating effect of information disclosure is the Danish
ready-mixed concrete case. In 1993 the Danish Competition Council decided to gather and
regularly publish actual transaction prices set by individual firms. In the following years price
dispersion between firms decreased and the average price level increased significantly. An
academic study found that the information exchange facilitated collusion (Albaek et al.
1997).
However, Genesove and Mullin (2001) also point out that anonymising data may increase the incentive for
firms to participate.
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Type
Time period
Aggregation
Disaggregated (individualised)
Availability
Source: CRA
Despite these wide ranging agreements conflicts regularly arose and required resolution. The
managers met once a week and discussed whether certain incidences were to be judged as
deviations or not. They also used these meetings to agree on retaliatory behaviour if one
member of the colluding firms has been found cheating.
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Thus, although economic models usually work with simplified models that require
information about the prices and the quantities, in practice effective monitoring is much
more challenging.
Another requirement is that the cheating can be detected sufficiently fast, in order to limit the
gains from cheating. Thus, revealing prices that refer to the distant past may not be useful.
The specific critical time period depends on the frequency of sales and the time horizon of the
industry managers.
In order for collusive strategies to work it is often important to identify the prices and
quantities of individual firms. An example is the Fatty Acids case (1986). The industry was
dominated by three large firms and a large fringe of about 40 small producers. The industry
operated with an information exchange agreement with the trade association distributing
aggregate industry data. In 1979 the market leader initiated contacts with the other two large
producers which led to an information exchange agreement among these producers which
covered firm data on yearly sales and future four-monthly reports about total sales. This
information was used to discriminate the competitive strategies: customer switches between
the three main competitors were labelled stolen sales, gains of new customers legitimate
gains. It has been argued that the existence of an individualised information exchange
programme is easier to prove than collusion and therefore this type of information exchange
should be disallowed (see Khn 2001).
This example shows that competition concerns can be effectively addressed by aggregating
(anonymising) the data. If this method is effective, individual operators can cheat under the
shelter of total demand. Moreover, a two pronged strategy that discriminates between
competitors becomes much more difficult.
Making the information accessible to all market participants would have revealed the strategy
of the three dominant producers in the example above. In other cases it may just simplify the
information exchange.
Thus, it is not possible to provide a general statement regarding the competitive assessment of
private vs. public information.
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Time period
Aggregation
Disaggregated (individualised)
Availability
Source: CRA
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Time period
Aggregation
Disaggregated (individualised)
Availability
Source: CRA
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